Description

CERTAIN STATEMENTS CONTAINED HEREIN REFLECT THE OPINION OF THE AUTHOR AS OF THE DATE WRITTEN. NO INVESTMENT DECISIONS SHOULD BE BASED IN ANY MANNER ON THE INFORMATION AND OPINIONS SET FORTH IN THIS REPORT. YOU SHOULD VERIFY ALL CLAIMS, DO YOUR OWN DUE DILIGENCE AND/OR SEEK ADVICE FROM YOUR OWN PROFESSIONAL ADVISOR(S) AND CONSIDER THE INVESTMENT OBJECTIVES AND RISKS AND YOUR OWN NEEDS AND GOALS BEFORE INVESTING IN ANY SECURITIES MENTIONED. Please see additional Important Disclaimers at the end of this analysis.

Investment Overview

I believe Toll Brothers (NYSE: TOL) represents a compelling risk/reward at the current price/valuation as of 9/16/22. TOL is the leader in the U.S. luxury homebuilding market (operating in 24 states and 60+ markets) and fifth largest U.S. homebuilder by revenue. TOL is trading at 0.9x tangible book value per share (TBV/share) of $48.74. This TBV is largely comprised of 82,100 lots (39,900 owned/42,200 optioned equating to about eight years of unit sales) that were mostly acquired at pre-COVID pricing. And most of those lots were purchased post-approval to build. Additionally, 80% of its homes are pre-sold build-to-order with an average deposit of $80K on an average delivered price of $875K. I think this provides a nice margin of safety to an investment at current prices. Executives and directors own ~7% of shares, which helps align their interests with other shareholders.

With several homebuilders trading at seemingly low valuations, the debate as to whether a potential investment in TOL is attractive likely has to do with one’s view of the macroeconomic outlook, especially as it relates to housing. To me, it largely comes down to affordability. There is huge pent-up demand and a lack of supply. Fiscal and monetary policy has helped result in high asset inflation and now with rising interest rates and cost-of-living inflation, this hurts affordability even more than pre-COVID. There are various industry/company-specific positives and negatives as I see it.

Positives:

·      Pent-up demand: from 2010-2020, new-home construction fell 6.8M units short of what was needed to meet household-formation growth and replace obsolete units

o   From 2008-2021 average annual housing starts were 1.03M compared to 1.54M from 1970-1999 (and 1.74M from 2000-2007)

o   Home ownership rate rising, but still below historical norms

·      77M Millennials entering their home-buying years

·      According to TOL, the average age of homes in the U.S. has increased from 25 years in 1989 to currently 40 years, which makes a newly built home relatively more attractive, especially as the cost to maintain an older home has risen with higher labor and construction materials costs

·      Greater adoption of work-from-anywhere allows more homebuyers to choose where they want to live, which I believe plays into TOL’s strength of high-end, high-quality homes in top suburbs that are more affordable than high-cost urban markets

·      I believe a growing number of institutional and financial buyers of homes provide greater support to the housing market

Negatives:

·      Affordability challenges from the rapid rise in interest rates (all be it low on a historical basis) and home prices

·      Constrained supply of new homes

o   TOL operates in many of the most difficult land approval markets in the U.S.

Valuation/Expected Return: TOL has been improving its operational performance over the past decade and therefore one could argue it deserves to trade at a higher multiple than it has historically. It has become more capital light by using more optioned lots vs. owned, which has helped increase its inventory turns from 0.5x in 2015 when just 19% of its controlled lots were optioned to 0.8x in the LTM with 51% of lots optioned. During this time, total debt/equity has gone from 89.6% to 62.0%.[i]

Over the past 10 years, its average price/TBV multiple has been 1.4x and its ROE has averaged 12.2% (19.2% in the LTM).[ii] I estimate TBV/share at the end of 2023 will be ~$55. Applying 1.4x to that plus ~$1 in dividends collected over the next five quarters equates to ~$78 or a potential total return of ~70%.

Realizing we are likely at peak housing prices given affordability issues, if the U.S. was to see a housing correction akin to what we experienced during the GFC where TOL’s TBV/share declined by ~35% from 2007-2010, applying 1.4x to a similar decline to TBV/share would be about where the stock is currently trading. It’s worth noting that from its peak TBV/share during the GFC, it has grown TBV/share at a 5.2% CAGR over the past 15 years.

Risks: Housing bubble akin to what we saw during the GFC results in further pressure on homebuilder stocks.

Note: unless otherwise noted, all statistics related to TOL are from its Q3’22 Earnings Call Presentation (8/24/22). 

Important Disclaimers

The provision of this report does not constitute (and should not be construed as) a recommendation, financial promotion, investment advice, encouragement or solicitation to buy, sell, or hold the security of the subject issuer (the “Security”), or any other securities, discussed herein. This report is for informational purposes only. All of the information contained herein is based on publicly available information with respect to the security and the author’s analysis of such information. Past performance is no guarantee, nor is it indicative, of future results.

Certain statements reflect the opinions of the author as of the date written, may be forward-looking and/or based on current expectations, projections, and/or information currently available. The author cannot assure future results and disclaims any obligation to update or alter any statistical data and/or references thereto, as well as any forward-looking statements, whether as a result of new information, future events, or otherwise. Such statements/information may not be accurate over the long-term. The views are those of the author acting in his individual capacity and not as a representative of the firm.  The author’s opinions on this Security may change at any time in the future and the author will not, and disclaims any obligation to, update this report to reflect any change in opinion. The author further disclaims any obligation to respond to any comments or questions posted regarding the Security discussed herin.

NO INVESTMENT DECISIONS SHOULD BE BASED IN ANY MANNER ON THE INFORMATION AND OPINIONS SET FORTH IN THIS REPORT.  YOU SHOULD VERIFY ALL CLAIMS, DO YOUR OWN DUE DILIGENCE AND/OR SEEK ADVICE FROM YOUR OWN PROFESSIONAL ADVISOR(S) AND CONSIDER THE INVESTMENT OBJECTIVES AND RISKS AND YOUR OWN NEEDS AND GOALS BEFORE INVESTING IN ANY SECURITIES MENTIONED. AN INVESTMENT IN THE SECURITY DOES NOT GUARANTEE A POSITIVE RETURN AS STOCKS ARE SUBJECT TO MARKET RISKS, INCLUDING THE POTENTIAL LOSS OF PRINCIPAL.

The author or his or her respective employer or employer’s clients, affiliates, officers, managers and directors, may or may not hold positions in the Security noted in this article. These parties may trade at any time, without notification to this community, and will not disclose this information to this community. The author and his employer disclaims any liability for investment losses that you may incur under any circumstances.

The author does not hold a position with the issuer of the Security such as employment, directorship, or consultancy.

[i] Toll Brothers Q3’22 Earnings Call Presentation (8/24/22), Capital IQ as of 9/16/22

[ii] Capital IQ as of 9/16/22

Catalyst

Time, but I would not be surprised to see a private equity bid given the seemingly cheap valuation and digestible market capitalization of ~$5 billion.